Oil Money: A Crude Question

Rahul Oberoi/Money Today | Print Edition: May 2011

% change during Sept 2010-Mar 2011
If you have stocks of some petroleum companies in your portfolio, you might be on slippery ground with crude oil prices surging past the $115 a barrel mark in March. This is a rise of 45% since September 2010.

As a result, during the September 2010-March 2011, the stocks of oil marketing companies (OMCs) and refining companies were beaten down considerably, correcting in the range of 20-35% and 7-15%, respectively. However, oil explorers, have not fared badly, hoping to cash in on the rising crude prices. Along with ONGC, Reliance Industries Ltd (RIL) and Oil India are among the favourite stocks of analysts whom Money Today contacted. (See Top picks)

Market experts see the outlook for stocks of oil refining companies getting worse as it is feared that crude prices will soon touch $120 a barrel on expectations of economic recovery in the developed nations, and continued political unrest in the Arab world.

So, what investment strategy should you follow for the petroleum sector? Analysts say crude oil price should not be the only barometer used to take investment decisions. Dipen Shah, vice-president, private client group research, Kotak Securities says, "Before buying oil stocks, investors should also check the global demand scenario, inventory levels, geopolitical issues and gross refining margins (GRM) of companies." GRM is the difference between the value of petroleum products and price of crude.

R Murlikrishnan, head, institutional broking, Karvy Stock Broking, adds to Shah's criteria "You should look at the business model, global demand and the regulatory environment and see whether these affect the earnings of the company you plan to invest in."

"Brent crude prices are expected to be in the range of $125-130 by the end of June."
Basant Vaid
Senior Research Analyst, Bonanza Portfolio

OMCs such as Indian Oil Corporation (IOC), Hindustan Petroleum Corporation Ltd (HPCL) and Bharat Petroleum Corporation Ltd (BPCL), which have been burdened by under-recoveries for decades now, are not allowed to increase the prices of petroleum products in proportion to the rise in prices of crude globally. This obviously hits the bottomlines of these companies.

According to a recent research report by IIFL, for the first nine months of 2010-11, gross underrecoveries for oil marketing companies were Rs 47,000 crore based on the crude oil price average of $80 per barrel. In the fourth quarter of the fiscal, crude oil prices averaged about $101 per barrel resulting in gross under-recoveries of about Rs 25,000 crore taking the total to Rs 72,000 crore.

Between September 2010 and March 2011, the share price of HPCL slid 33.21% to Rs 356.95. BPCL and IOC fared a little better and were down 21.55% to Rs 611.30 and 21.14% to Rs 334.25, respectively, during the period.

"The recent price correction is a confluence of unclear regulatory initiatives on the subsidy-sharing mechanism and the compensation to the OMCs. But in our view OMCs are trading at book value and look attractive buys at this point in time," Karvy's Murlikrishnan adds. Looking at standalone refiners, quite a few of them are in trouble due to the rising cost of crude oil.

Top picks

If crude oil price corrects and subsidy burden gets reduced, the net realisation for the PSU exploration major ONGC would be higher. KG block basin seems to hold potential.
Angel Broking

The increase in gas price to $4.2 per mmbtu is a big positive for the government-owned oil exploration company as it improves its revenue and profitability.
LKP Securities

The refining margins are expected to remain strong in the near term. Besides, the alliance with BP will enhance the upstream activity of the largest refiner in the country.
Angel Broking
As a result, the stock prices of Mangalore Refinery and Petrochemicals (MRPL) has declined 16% to Rs 64.35 and Chennai Petroleum Corporation (CPCL) has retreated 7% to Rs 223, in the last seven months.

However, with the increase in GRM in the last quarter of 2010-11 to $6-7 per barrel, analysts expect refining companies to pick up, "Due to the closure of refineries in Japan following the earthquake, demand for refining companies in India has gone up. The refining margins have risen led by rising diesel spreads. Indian refiners are diesel-centric, hence, they stand to gain the most from the jump in diesel spreads. We expect marginal price hike in diesel after the state assembly elections," says Deepak Darisi, analyst with Mumbai-based brokerage LKP Securities.

RIL, which has refining as well as oil and gas exploration operations, has beaten the general downward trend and surged around 12% during September 2010-March 2011. "RIL is exporting their refined products at international prices which results in better realisation. Hence, the stock has performed better than those of OMCs," Dipen Shah adds.

However, Darisi cautions, "The negative news from KG-D6 that the production of natural gas is going down is acting as a dampener for the stock." In the first quarter of 2011, RIL dipped 0.6% to close at Rs 1,047.80 on the last day of March.

Among the major oil exploration companies, Cairn India's share price rose around 3% since September 2010 to close at Rs 351.25 on March 31, 2011. "Cairn is the company with the highest leverage to crude oil price. Since crude oil prices have rallied, the company has performed well. However, current crude oil prices do not seem to be sustainable," says Sarabjit Kour Nangra, vice-president, research, Angel Broking.

Public sector explorers, which are expected to share the subsidy burden with OMCs, however, were shunned by shareholders. Oil and Natural Gas Corporation (ONGC) dropped about 13% since September 2010 to close at Rs 290.10 on March 31, 2011. "The delay in the follow-on public offer (FPO) and uncertainty about the issue pricing led to the fall in the ONGC stock price. Market fears that the issue would be priced at a discount to the current market price led to the decline." says Mayur Matani, analyst, oil and gas, ICICI Securities.

"High oil prices are good for private upstream players and refiners who do not have to bear the oil subsidy burden, they affect the downstream players (fuel retailers) adversely as they have to bear the subsidy burden for selling diesel, kerosene and LPG at government administered prices. Deregulation of diesel prices is unlikely to happen in the near term due to high inflation and upcoming state elections," says Anil Chopra, chief executive officer, Bajaj Capital."

But not all oil exploration companies have done well. Aban Offshore, Hindustan Oil Exploration Company (HOEC), Jindal Drilling and Industries, and Oil India stock prices declined around 21% to Rs 616.15, 15% to Rs 200.85, 22% to Rs 452.95 and 10% to Rs 1,312.85, respectively, during the period between September 2010 and March 2011.


Brent crude prices are expected to stay strong during the June quarter, experts say. Basant Vaid, senior research analyst for commodities at Bonanza Portfolio says, "Prices are expected to be somewhere in the range of $125-130 by the end of June. These higher price levels will be seen for quite some time as the tensions in West Asia are not likely to be resolved anywhere in the near future. We may expect the crude prices to rise further during the second half of the year on the same concerns that drove Brent crude prices to a two-and-a-half year high above $120."

"The near-term outlook for oil depends on three factors - events in the Middle East and North Africa (MENA) region, quantitative easing in the US and incremental demand from China," says Chopra.

"In our view oil marketing companies are trading at book value and look attractive buys at this point in time."
R Murlikrishnan
Head, Institutional Broking,
Karvy Stock Broking
The MENA crisis, however, appears to be the most unpredictable as the second round of quantitative easing announced by the US Federal Reserve should expire by June 2011. There have been no signals from the US government about a third round. Also, the incremental demand from China is expected to ease with the government's attempts to cool down the economy with successive interest rate hikes.

As far as the fundamentals of petroleum companies are concerned, most have posted good numbers in the quarter ended December 31, 2010. HPCL posted a net profit of Rs 211.03 crore, up 572%, against Rs 31.40 crore in the corresponding quarter in the previous year.

Among others, IOC, ONGC and RIL posted Rs 1,634.76 crore (up 132%), Rs 7,083.23 crore (up 132%) and Rs 5,136 crore (up 28%), respectively, as net profit, as against the corresponding quarter in the previous year. On the sales front, HPCL has posted a 23% growth followed by ONGC (up 21%), Oil India (up 17%) and IOC (up 16%).

In the last quarter of the 2010-11, oil majors are expected to register good bottomline figures. "Oil India, ONGC and Cairn India are likely to report strong quarterly results. The improvement in Singapore refining margins from $5.5 per barrel in the third quarter of 2010-11 to $7.4 per barrel in the fourth quarter would help RIL to increase its profit year-on-year as well as quarter-on-quarter," adds Mayur Matani.

Market experts believe that this is the right time to invest in OMCs as the valuations are looking cheap. "We believe in the second half of 2011-12, the government might increase retail fuel prices as inflation is expected to be lower. Hence, investors can look at these stocks at that time provided crude oil prices either correct or remain stable," Kotak's Dipen Shah added.

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